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“The latest economic news from around the world gives some reason for cautious optimism,” said John Lipsky, the IMF’s First Deputy Managing Director, in a speech in Paris on June 26. “Tentative signs are emerging that the rate of decline in global output is moderating and that financial conditions are improving.”

Speaking at an IMF-organized conference, Lipsky said it was far too early to draw firm conclusions. But he said this news “offers positive reinforcement for the unprecedented efforts under way to resist the unprecedented challenge. After all, the breadth and severity of the financial crisis and economic slowdown are the most serious experienced since the 1930s.”

Nevertheless, he said that ongoing policy support would be crucial in laying down firmer foundations for renewed growth, including the restoration of financial sector health.

Caution warranted

Lipsky said policymakers around the world had responded with flexibility and ingenuity, using all the weaponry available in their arsenal, including large-scale fiscal stimulus, very accommodative monetary policy, plus strong and often innovative support for the financial sector. “The speed and magnitude of the policy response no doubt played a key role in beginning to turn around market sentiment, in slowing the decline in economic activity, and in truncating the downside risks,” he told the conference.

But while clear signs of recovery are visible in some emerging markets, particularly in Asia, the recovery still appears to be struggling to become established in most advanced economies, Lipsky stated.

Countries should not relax their fiscal stimulus measures. “Regarding fiscal policy, the implementation of the announced stimulus measures is an incomplete challenge.”

Actual spending falls short

Lipsky said that although experience varied across countries and programs, actual spending of announced stimulus measures was relatively low in many cases. In the United States, for example, while payroll tax cuts had been implemented relatively quickly, only $46 billion or 11 percent of authorized spending measures, had taken place through mid-May, concentrated in health and human services.

“It is straightforward to conclude that the spending measures already announced must be implemented if they are to support the incipient recovery. Moreover, if the signs of recovery turn out to be a false dawn, consideration may need to be given to providing additional stimulus,” he added.

The IMF, which has forecast an end to the recession later this year, with a recovery in 2010, will give its latest projections for global economic growth on July 7.

Boosting lending

Lipsky said that on the monetary front, despite some normalization of inflation expectations, monetary policy should remain accommodative for the time being, including through “unconventional measures” where needed. Together with budgetary support, low policy interest rates and steeper yield curves help strengthen financial institutions’ earnings and balance sheets, which would hopefully boost lending to the private sector.

“Monetary policy has been relatively successful in normalizing conditions in money markets, but has had less influence over longer term interest rates. Similarly, efforts to stimulate bank lending and restart securitization markets must contend with a more fundamental lack of confidence among creditors,” he added.

Start thinking about exit strategies

Lipsky raised the issue of how to unwind the stimulus measures once they have been effective in reviving growth. “As the danger of a total financial system collapse has ebbed, we need to avoid new vulnerabilities further down the road. We also need to start preparing a clear exit strategy for government intervention in both the fiscal and monetary areas,” he said.

“The deployment of numerous instruments to stimulate demand and support the financial sector, together with the operation of automatic stabilizers—all essential to avoid a much more serious crisis—leave at the same time a legacy of fast growing government liabilities and bring us to uncharted territory,”

Government debt is now projected to grow at a rapid pace for several years, and in the case of several advanced economies, approach the highest level since World War II. Policymakers must navigate skillfully between avoiding a premature withdrawal of fiscal stimulus that would nip the recovery in the bud, and, on the other hand, allowing debt to increase to levels that would cause concerns about fiscal sustainability, Lipsky added.